For individuals new to the stock market, it is a little-known fact that there is an enormous difference between day trading and investing. Television and internet ads often promote each discipline with very similar tactics, suggesting that success is a foregone conclusion for almost anyone in the market. Elementary mantras such as "buy low and sell high" insinuate that making money is straightforward, even easy. While profit is the reason most participants show up to work everyday, stock day traders secure marketshare in a unique fashion.
In truth, day trading and investing feature a unique collection of pros and cons; some intuitive, others not. However, no matter which course of action is pursued, meeting certain prerequisites is necessary to ensure a legitimate chance of success.
To become a stock market day trader, one must secure market access, build a viable trading plan, scrutinise performance and adhere to official rules. Although these steps are nuanced from traditional investing practices, they may be completed in a timely fashion given proper due diligence.
Step #1 Secure Market Access
The term "market access" refers to the ability of an equities trader to buy and sell shares of stock on the open market. It is the backbone of day-to-day operations. Without quality market access, conducting business is impossible.
One of the key advantages afforded to modern traders is the increased accessibility of the capital markets. The trade of futures, forex and equities products are now conducted almost exclusively online, which has vastly reduced the barriers to entry for aspiring traders. All that is needed are the following inputs to engage stock markets around the globe:
- Computing Power: A desktop PC, laptop or mobile device is necessary to use the software trading platforms.
- Internet Connectivity: Robust internet connectivity is required for data transmission to and from the exchange.
- Brokerage Account: Commissioning the services of a brokerage firm for the facilitation of stock trading activities is mandatory.
Advances in information systems and internet technologies have opened the capital markets to the world. A quote from author and trading legend Dr. Alexander Elder sums up the benefits of the contemporary marketplace:
"You can be free. You can live and work anywhere in the world. You can be independent from routine and not answer to anybody."
Step #2 Review Local Rules And Guidelines
While Dr. Elder's quotes are attractive to many aspiring stock day traders, they aren't 100% accurate. The freedom of remote market access is very real. However, all market participants are accountable to regulation and oversight.
For stock day trading, the rules of engagement vary according to country, region, municipality and market. While some jurisdictions practice a relaxed regulatory framework, others are much more strict. Before ever placing a trade, it is critical to be aware of pertinent regulations.
A good example of invasive guidelines designed specifically for stock day traders are those privy to the U.S. equities markets. The top two equities exchanges in the world are headquartered in the U.S.: the New York Stock Exchange (NYSE) and NASDAQ. Day traders involved in these markets must adhere to regulations put forth by the Financial Industry Regulatory Authority (FINRA) and the U.S. Securities and Exchange Commission (SEC). According to FINRA rules, active participants are subject to the following mandates:
- Pattern Day Trader Designation: Since 2001, the phrase "pattern day trader" has been used by FINRA to describe anyone that opens then closes an intraday position four or more times in five business days. In addition, the number of day trades must be more than 6% of the total number of trades executed during the same period.
- Increased Margin Requirements: As a pattern day trader, individuals are required to maintain a minimum of US$25,000 during any session in which a trade is executed.
Regulations such as these greatly reduce the pool of people that can practically day trade U.S. stocks. The increased capital requirements often prompt active traders to target other international exchanges, related contract-for-difference (CFDs) products, or equities-based futures contracts.
Step #3 Build A Trading Plan
Even though securing market access and being aware of regulations are both necessary, having a comprehensive trading plan is the lifeline for the day trader. It provides a strategic framework that thoroughly addresses market entry, exit and risk management. Not having one in place is a leading reason behind the high washout rate among short-term traders.
A comprehensive plan takes the guesswork out of stock day trading by removing any ambiguity associated with the following areas:
- Methodology: Whether a strategy is based upon fundamental, technical or hybrid analysis is a key part of the entire plan. Each type will largely determine the resources needed to sustain operations.
- Trade Selection: The ability to spot opportunities is an integral part of any approach to the markets. A viable trade has a positive expectation or "edge," meaning that its chance of long-run success is better than 50/50.
- Position Management: Managing open positions in live market conditions can be an epic challenge. For stocks, clearly defining an exit point, as well as evaluating the potential impact of evolving price action, are tasks critical to optimising performance.
- Money Management: Properly implementing leverage while aligning risk to reward may be the most important aspect of any stock day trading strategy.
Through defining each of the above facets of trade, a comprehensive plan is able to promote consistency and disciplined behaviour within the marketplace. In addition, a statistically verifiable track record is produced, which is useful for identifying specific strengths and weaknesses.
Step #4 Execute The Plan
Now it's time to put the trading plan into action and begin buying or selling stocks. At this point, the guesswork involved with a strategy's application should be minimal. Nonetheless, there are still a variety of routine tasks that must be completed in order to day trade stocks competently. Below are a few of the most important:
- Equipment Maintenance: Regular maintenance of the computer, internet connection and software platform can eliminate unwarranted latencies.
- Market Study: Staying current is a big part of capitalising on opportunities or adapting the overall plan. Shifts in consumer trends or geopolitics can influence the underpinnings of almost any asset's value, including corporate stocks.
- Performance Evaluation: Periodically conducting a performance evaluation is vital to rectifying any issues that may be hampering profitability. Personal inventories, as well as brokerage evaluations, can help identify and improve problem areas.
The global equities markets are ripe with potential opportunities of all kinds. From long-term investment strategies to high-frequency scalping possibilities, corporate stock offerings can be a valuable part of any trader's approach to the markets.
To excel in a competitive discipline such as stock day trading, it is imperative to engage the market with discipline, dedication and competency. Without these three inputs, achieving even a moderate degree of success may prove to be a monumental task.
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…